The Minister for Finance Paschal Donohoe intends to merge the universal social charge and PRSI into a single social insurance payment. This proposal which might be implemented over a number of budgets raises a number of issues. It also has the potential to shift part of the tax burden from the young to the old which could give rise to controversy.
At present there are three different taxes on income in Ireland: income tax, USC and PRSI. Income tax will yield about €16.5 billion, USC €3.7 billion and employee PRSI €2.7 billion in 2017. The combined effect of USC and PRSI is to add up to 15 percentage points to the marginal rate of tax.
At present, USC and Employee PRSI are applied to different tax bases and have different rate structures and thresholds. For example USC does not apply to deposit interest while PRSI does not apply to occupational pensions or income accruing to people over State pension age (now 66). Neither USC nor PRSI apply to welfare payments or capital gains.
In approaching this issue, it is useful to set out some key principles.
First, the objective should be to levy the unified charge on as broad a base as possible. All the evidence suggests that taxes with broad bases and low rates are preferable to taxes with narrower bases and necessarily higher rates.
Secondly, after taking account of different circumstances, people with the same incomes should pay the same amount of tax. For example, a pension of €30,000 derived from the public sector pension scheme yields nearly four times as much USC as a private sector pension of the same amount derived from a combination of the State Contributory Pension and a private scheme.
Thirdly, major discontinuities in the rate structure should be avoided. For example, an increase of €1 in income can lead to an additional USC liability of about €60 when the threshold of €12,012 is reached.
A number of issues arise
- How should the tax base be as broad as possible?
- What threshold should be used ?
- How should self-employed be treated ?
- How should welfare payments such as dependency allowances and child benefit be treated ?
- Should the new unified tax be on a cumulative or non-cumulative basis ?
- What deductions/exemptions should be allowed for PRSI purposes ?
- Should the new unified tax have a progressive rate structure ?
Broadening the Tax Base
Since 2009 there have been a number of extensions to the PRSI Base. These include the abolition of the employee ceiling for charging PRSI, the abolition of relief from PRSI previously applied to employee pension contributions, the abolition of the employee PRSI-free allowance as well as the extension of the PRSI base to unearned income such as rental income, investment income, dividends and interest on deposits and savings.
There is scope to broaden the base further by extending PRSI liability to
- Income arising to persons of State Pension age (now 66). Such income is currently liable to USC except for welfare payments and deposit interest
- Capital gains and income subject to exit tax1 .
At present USC is payable on all income once income exceeds €12,012. Employees pay PRSI in any week once income exceeds €352. Self-employed are liable for PRSI once income exceeds €5,000 per annum (minimum charge €500). Under a unified tax these thresholds should be aligned.
Treatment of Self-Employed
The treatment of self-employed individuals should be aligned with that of employees in so far as the threshold for liability should be the same. In addition the higher rate of USC imposed on self-employed persons with incomes over €100,000 should be the same as that imposed on others with the same income. Separate consideration needs to be given to the conditions which both self-employed and employed people need to satisfy in order to qualify for welfare benefits.
At present, all welfare payments are exempt from both USC and PRSI though all are charged to income tax except child benefit.
The exemption of social welfare pensions from USC costs about €350 million and it would seem fairer to treat this income for USC and PRSI in the same way as it is treated for income tax.
Where the qualifying conditions for rent-a-room relief are satisfied, the income in respect of which the relief applies is exempt from PRSI, and USC. Where the qualifying conditions for rent-a-room relief are not satisfied, the income is subject to PRSI and USC in the normal manner. It would seem simpler to continue these exemptions.
Cumulative or Non-Cumulative
USC and income tax are charged on a cumulative basis in that liability is based on the total income received during a calendar year. On the other hand liability to employee PRSI is determined on weekly or monthly basis. Self-employed individuals pay PRSI on an annual basis.
Provided any administrative difficulties can be overcome, it would seem fairer if all taxes on income were paid on a cumulative basis.
Income Distribution Effects
Extensions of the PRSI base have the potential to raise considerable sums at existing rates of PRSI and as such would have significant income distribution effects. In particular, there would be a rebalancing of the tax burden from the young to the old. A change to a system where tax liability is related to income where those with the same income pay the same tax inevitably increases tax on older people who enjoy relatively favourable treatment under the current regime.
At present employee PRSI is charged at a flat rate once income exceeds a particular threshold while USC has a progressive rate structure. It would be very difficult to have a progressive PRSI rate structure under the present non-cumulative system as this would disadvantage those with variable earnings. The question arises whether or not the new unified PRSI should be charged at a progressive or flat rate.
A flat rate system would be simpler. Given that we already have a progressive rate structure for income tax it may be sufficient to have one element of the system with a progressive structure.
1 Exit Tax is a tax payable at 41% on any profit made on collective investment funds and life assurance savings products. Exit tax was introduced in January 2001 on all life savings plans and investment bonds (unit-linked, unit trusts, UCITS)